Hedge Fund Leverage Falling

Are hedge funds becoming more conservative? Hedge funds being hedge funds, of course, nobody knows for sure. But the best data there is comes from the Financial Services Authority in the UK, which polls prime brokers and asks them how much money they're lending to hedge funds. And by that measure, leverage is actually going down, not up.

Hedge funds reduced their gearing last year by about 10 per cent, according to a private survey by British regulators, lowering the potential for the failure of a major firm to create a domino effect across the financial system.
The survey by the Financial Services Authority of prime brokers, the main lenders to hedge funds, found gearing dropped from 1.86 times net equity in April to 1.66 times in October, said people briefed on the results...
The FSA declined to give details of its findings. But it said: “The survey shows that leverage remains at moderate levels and lending is well covered by collateral."...
Two senior prime brokers said hedge funds were increasingly bypassing the prime brokerages on which they have traditionally relied for borrowing, so some of the leverage in the industry would not be seen by regulators.

Lower leverage is good news as far as the systemic risk of hedge funds is concerned. On the other hand, if hedge funds are simply getting there leverage elsewhere, and bypassing the prime brokerage system, that's very bad news. After all, the prime brokers are exactly the point at which people like Tim Geithner want to concentrate regulatory efforts with respect to hedge funds.